Question

Tokyo Food Supplies Corporation sold an issue of 12-year bonds. The bonds sold at $953 each. After issuance costs, Tokyo Food Supplies received $948 each. The maturity value is $1,000 each and the coupon rate is 11% and paid annually. What is the after-tax cost of debt for these bonds if Tokyo Food Supplies’ marginal tax rate is 35%?

P/Y
Beg/End
N
I/Y
PV
PMT
FV

7.69%

11.83%

9.76%

4.14%

Answer 1

After-Tax Cost of Debt

The After-Tax Cost of Debt is the After-Tax Yield to maturity of (YTM) of the Bond and is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Face Value [$1,000]	FV	1,000
Coupon Amount [$1,000 x 11%]	PMT	110
Yield to Maturity [YTM]	1/Y	?
Time to Maturity [12 Years]	N	12
Bond Price [-$948]	PV	-948

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the yield to maturity (YTM) on the bond = 11.83%

The After-tax Cost of Debt is the after-tax Yield to maturity of the Bond

After Tax Cost of Debt = Yield to maturity x (1 – Tax Rate)

= 11.83% x (1 – 0.35)

= 11.83% x 0.65

= 7.69%

“Therefore, the After-tax Cost of Debt will be 7.69%”